What a difference a year makes

The foreign exchange business was a clear outlier in what has been a historic year for global financial markets. But no single entity experienced as significant a reversal of fortunes as a result of the market turbulence this year as settlement system CLS.

The year began with a continuation of the themes from 2007, as dealers, particularly those with large FX prime brokerage businesses, continued to struggle with capacity constraints and costs associated with processing high volumes of low-value tickets. In the drive to reduce these costs, focus landed on reducing or avoiding altogether CLS settlement charges for these trades, as a cheaper alternative to expanding back-office capacity. Initiatives emerged to bypass CLS, which, based on member consensus, was not accepting netted trades for settlement.

One such offering came from the now-defunct Reuters and CME joint-venture platform, FXMarketSpace, which launched an alternative settlement system FXSettle using the ‘on-us' settlement model. Meanwhile, vendors and a group of up to eight dealers began plans to develop another system.

Just as it seemed CLS was weighing further on that back foot - despite its ownership structure - Bear Stearns collapsed. CLS third-party providers, and CLS itself, noted interest in using CLS to manage settlement risk had risen. Then the single biggest event of the year occurred, sending a series of penetrating shocks waves throughout the industry - the September 15 bankruptcy filing of Lehman Brothers Group.

From that date onwards, the catastrophe spiralled as a continuing lack of interbank funding in October led to the domino collapse of Iceland's three largest commercial banks and the government bail-out out of UK institutions such as Royal Bank of Scotland. Banks that had previously shown no interest in CLS soon became keen to sign on, while major dealers started to incorporate CLS into their plans for growth.

And last week it emerged Bank of Canada might have convinced Bank of Nova Scotia to drop its resistance to CLS and join, in order to stabilise the domestic financial markets. The Canadian dealer is due to go live as a member next year.

What a difference a year makes.

Next year, it's unlikely the evolution of the FX market will stop, although the drivers might be different, with a focus on improving pricing of risk. But the beauty of the FX industry is its willingness to innovate in order to self-regulate.

Saima Farooqi, Editor

Comments? please email saima.farooqi@incisivemedia.com